The Hidden Fees Inside Managed-Futures Funds

With investors fleeing mutual funds that charge high fees, some fund companies have finally been cutting expenses. Others, it seems, have been burying them.

Consider the odd contortions that managed-futures mutual funds go through in disclosing their expenses to investors. If your hobby is translating Egyptian hieroglyphics, you might enjoy spending a weekend trying to decode some of these funds’ financial reports. Other people should remember the ancient maxim: Don’t invest in something you can’t understand.

The problem isn’t that these mutual funds are inherently bad. Managed-futures portfolios, which rapidly buy and sell anything from soybeans and cotton to rubles and rupees, can diversify the risk of a conventional stock-and-bond approach. Nor are these funds always expensive: AQR Capital Management charges as little as 1.2% annually, a fraction of what hedge funds and other managed-futures vehicles cost.

Other such funds, however, make it hard for you to figure out what they do cost. With financial advisers promoting the virtues of managed-futures funds ever since the financial crisis burned so many investors in stocks and bonds, you should hold back from investing unless the costs are clear.

Mutual funds specializing in managed futures have total assets of $29.7 billion; in 2016, for the second year in a row, they took in more than $8 billion in new money, estimates Morningstar, the research firm.

What you — and your financial adviser — might not realize is that many of these funds don’t report all their expenses directly.

Consider the $1.5 billion Equinox managed-futures funds, based in Princeton, N.J. Several of Equinox’s eight portfolios don’t invest all their assets directly in futures contracts. They also use what are called total-return swaps — instruments created by a bank to mimic the performance of a financial asset. That asset can be just about anything, including the stream of results generated by a portfolio manager.

But banks — and those portfolio managers — take fees out of total-return swaps. The $574 million Equinox Campbell Strategy Fund, for instance, paid 0.35% of its assets in 2015 to cover bank fees on its swaps. It also pays 1% of its total assets and 20% of any trading profits to the portfolio manager whose returns are captured by the swap, Campbell & Co. of Baltimore.

Equinox Campbell Strategy reports “total annual fund operating expenses” of 1.15% in its March 2016 prospectus. But that “total” doesn’t include the swap expenses.

Instead, those costs are subtracted from the fund’s gross return. “The performance of the fund is net of all such embedded management and incentive/performance fees,” the prospectus says in a bold-face footnote.

In 2015 such costs came to at least 1.35%, which would have more than doubled the fund’s annual expenses if they had been included in the “total.”

Equinox and Campbell didn’t respond to requests for comment.

Other mutual funds, including three offered by Altegris Advisors of La Jolla, Calif., also use swaps and exclude the associated costs from the “total” expenses they report to investors.

Altegris says in a bold-face footnote to its prospectus that the incentive fees it pays through the total-return swaps “cannot be meaningfully estimated but generally range from 15% to 25% of the trading profits” and that its funds’ returns are reported “net of all such embedded incentive/performance fees.”

“We bold-face the statement at the bottom because we want to make sure people see it,” says Matt Osborne, Altegris’s co-founder and chief investment officer. “We want people to understand what they’re buying.”

Altegris plans to use a flat-fee structure in more of its funds, Mr. Osborne says. “We are very aware that low cost is vital, and we are moving actively in that direction.”

Believe it or not, investment lawyers say fine-print disclosures like those of some managed-futures funds probably comply with rules set by the Securities and Exchange Commission. But do they tell investors what they need to know?

You would probably feel surprised, perhaps even exploited, if you went to a restaurant that promised you don’t have to tip the staff — only to learn that the waiters eat 10% or 20% of your food before they bring it to your table.

The way some of these firms report their expenses is “one of the worst practices in mutual funds,” says Jason Kephart, an analyst at Morningstar who follows managed-futures portfolios. “It’s completely non-transparent.”

Fees always matter, but they loom especially large in managed futures. An authoritative study of nearly two decades of performance, published in 2014, found that the average commodity trading adviser outperformed cash by an average of 6.1% annually before fees — but less than 2% after fees.

Such high expenses turn potentially attractive returns into chump change — and make it vital to determine exactly how much a given fund is charging.

If your financial adviser recommends that you invest in a managed-futures fund, ask him or her to prove to you that the fund includes all its costs — including on swaps and other offshore vehicles — in its total reported expenses. If you’re looking at such a fund yourself and can’t figure out how much you will have to pay to own it, don’t buy it.